Why the 'market hasn't fully understood' this ASX rare earths share with huge upside

Portfolio manager picks rare earth minerals stock to buy now, but it's not the one you’re thinking of.

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Electric vehicle maker Tesla Inc (NASDAQ: TSLA) sent a shiver down the spine of rare earths miners around the globe earlier this year.

The US company declared that it would shift its battery technology to no longer use rare earth minerals, to free itself from future supply shortages.

So how realistic is this?

Is it just another impulsive thought bubble from mercurial chief Elon Musk, or can it actually happen?

Tyndall Asset Management portfolio manager Jason Kim set about to answer this dilemma, and named the ASX rare earths stock that he would buy right now:

The fact that many people don't realise is that earlier model Teslas didn't use rare earth minerals.

"Tesla had previously used AC induction motors (with no rare earths) in their earlier models but replaced them with permanent DC magnet motors which contained rare earths (NdFeB magnets)," said Kim on the Tyndall blog.

"Tesla's decision to switch away from AC induction motors was driven by a range of factors, including problems with unbalanced voltage supply, rotor locking, and interference with the complex network of sensors found in modern vehicles."

Because of these problems with AC induction, Kim added that many experts can't see the car maker returning to that technology.

So how would Tesla move away from rare earths now?

According to Kim, the "only current feasible alternative" to rare earths magnets is ferrite magnets.

These magnets are already used in EV motor designs from Japan's Proterial and Germany's Bayerische Motoren Werke AG (ETR: BMW).

But it comes at a cost.

"While ferrite powered motors can match the performance of NeFeB powered motors to some extent, this performance comes with a significant weight and efficiency penalty that has made the switch unattractive to date."

If Tesla wants to make the switch, it has to accept trade-offs like lower driving range or a larger battery.

"Given the bigger batteries, as well as more copper required, some experts believe there is no material cost advantage to using ferrite powered motors to NdFeB powered motors."

So Kim's verdict is that, despite Tesla puffing its chest out, it will not be able to easily transition out of using rare earths.

"It appears the demand for rare earths will continue to grow and that supply growth still remains an issue," he said.

"There are some possible advancements that may result in true alternatives to rare earths in motors, such as manganese bismuth magnets. However, they are all still in their development infancy, and their commercialisation, if they prove to work, is still several years away."

So considering rare earths shares are safe for now, which one would he buy on the ASX at the moment?

It's not the one you’re thinking of.

"Iluka Resources Limited (ASX: ILU), which is predominantly a mineral sands miner with a very large presence in titanium dioxide and zircon markets, has been a beneficiary of government support aimed at increasing the supply of critical minerals including rare earths," said Kim.

"This support will assist in the acceleration of Iluka's emerging, but potentially very large, rare earths mining and processing business."

The Iluka share price has already risen 20% year to date, all while paying out a dividend yield of close to 4%.

Kim reckons the stock provides "a unique and undervalued opportunity".

"The market has not fully understood the potential upside from their rare earths opportunity, and the significance of the government support that this project has received."

Motley Fool contributor Tony Yoo has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Tesla. The Motley Fool Australia has recommended Bayerische Motoren Werke Aktiengesellschaft. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.